Stock Quotes in this Article: BAC, C, HIG, MS, WFC

NEW YORK (Stockpickr) -- When it comes to bank stocks, memories linger long. The financial crisis of 2008, which led to disastrous outcomes for many major banks, is still on the minds of investors, even though these same banks are far healthier these days. With Europe still trying to figure out how to fix its trillion-euro mess, investors fear that U.S. banks will be dragged down in the maelstrom. That concern is off-base.

Simply put, U.S. banks have already gone to great lengths to quantify their exposure to Europe in general and Greece and Italy in particular. The key takeaway: A badly slumping Europe in 2012 would have a moderate impact, and EPS forecasts would be trimmed.

Notably, we’re talking about the difference between tepid profits and decent profits. Yet the fact that we’re talking about profits at all is the key consideration. That’s because a number of bank stocks trade for well less than tangible book value, and you usually only see that when companies are unprofitable and book value looks set to shrink.

In fact, these banks remain profitable, so barring an exogenous shock, book value should keep rising, as has largely been the case for much of the last six quarters for almost all of the names on the table below. The fact that all of these bank stocks trade for less than 10 times projected 2012 profits is just another measure of their value.

Of all the names on this group, Citigroup (C) may possess some of the most solid upside. Not only does Citi trade at a fairly large discount to tangible book value (a trade up to tangible book would yield a 61% gain from current levels), but the bank arguably has the most robust growth prospects in the sector. So book value will be more like a floor than a ceiling -- eventually. Citi’s growth is coming from heavy investments in Latin America and Asia, which are likely to be the most dynamic regions of the coming decade.

You can already see those investments paying off. In the most recent quarter, 63% of the bank’s customer-held assets were outside the U.S. In fact, 80% of Citigroup branches are in foreign countries. Lending in Latin America and Asia each rose more than 10% in the third quarter from a year earlier. Equally important, Citigroup has only a small presence in Europe and is unlikely to be deeply affected by any deeper weakness in Europe in 2012.

Shares have fallen from $50 to $30 this year, earning Citigroup a spot on a recent list of 2011's Bank Stock Losers, and a return to that early 2011 peak looks to be in the cards in 2012.

The Europe Reversal

If European policy-makers can manage to effectively tackle the current financial crisis, no bank stock would benefit more than Morgan Stanley (MS) -- simply because that bank, another of 2011's losers, has been most aggressively sold off on fears of an unmanageable exposure to Europe. And there’s reason for hope: Morgan Stanley’s credit default swaps recently fell to a one-month low as the outline of a continent-wide rescue plan took shape.

Here in the U.S., Morgan Stanley remains as a formidable player. It is likely to finish either first or second in U.S. equity underwriting. Investment banking fees are tracking 20% ahead of 2010 levels, compared with a 9% industry gain. And its brokerage arm is still one of the largest in the country, throwing off steady, predictable cash flow. Brokers of Morgan Stanley and Smith Barney joined forces under one banner after the 2008 financial crisis, and the combined entity is finally realizing long-planned integration synergies.

Yet a series of charges have impaired the balance sheet, so tangible book value hasn’t rebounded to the extent that it has at other banks. That figure stood at $27 in 2010 and is likely to finish this year at $27 as well. Analysts at Merrill Lynch figure that tangible book value will grow around 7% in 2012 and again in 2013 but concede that investors won’t get excited about the stock until that figure can move back up above 10%. When that happens, “the stock would support valuation above Book Value,” note the Merrill analysts. Considering that shares trade for just two-third of tangible book value, that actually represents some really impressive upside for this stock.

Perhaps the safest bank stock you can own isn’t even in this “below book” group. Shares of Wells Fargo (WFC) have been dragged down by sector concerns even though it is arguably least exposed to Europe of any major bank. This stock is back at levels seen in 2005, even though its revenue base is now 150% larger, thanks to both organic growth and key acquisitions.

That may explain why Warren Buffett has been continually loading up on shares as they’ve weakened. His investment firm, Berkshire Hathaway (BRK.A), currently holds 360 million shares, making it Wells Fargo’s biggest stockholder. The stock also shows up on a recent list of 10 Stocks Held by the Most Successful Fund Managers.

In light of the still-weak U.S. economy, management is using the time to root out any excess costs, in an initiative known as Project Compass. You won’t see the bottom-line benefits in the near-term, as EPS is likely to be flattish at around $3 a share in 2011 and 2012, as was the case in 2010. Yet when the U.S. economy finally becomes healthy, led by an eventually rejuvenated housing sector, EPS could explode well higher, perhaps into the $4-to-$5 range.

On a pair of occasions over the last two years, Wells Fargo moved up into the mid-$30s, only to be buffeted by broader banking sector concerns. Once the current European crisis passes (which should leave Wells Fargo unharmed no matter how it plays out), shares should re-visit those peaks. That 25% to 30% upside may be more modest than what Citigroup and Morgan Stanley might see, but the lower risk-profile compensates for that.


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At the time of publication, author had no positions in stocks mentioned.